This article was first published in the March 2012 UK edition of Accounting and Business magazine.
A financial transaction tax is almost the perfect tax in the eyes of supporters. Its advocates say the levy, proposed by the European Commission and strongly supported by the German and French governments, ticks several boxes.
It would, they say, raise a large amount of much needed revenue to fill the holes in government finances created by the credit crunch – and from the very financial services companies that caused it. It would discourage these companies from pursuing the sort of business that caused the crunch, and might even boost gross domestic product (GDP).
But to many of its critics the financial transaction tax – commonly called the Tobin tax after James Tobin, the Nobel Laureate economist who proposed it in 1972 – is just about the worst of all possible measures. They say it would reduce GDP – and that would hit tax revenue in turn. It would virtually wipe out entire mini-industries within the financial services sector. Moreover, it would not just punish financial services companies – whose role as the ultimate cause of the credit crunch is denied by Tobin tax critics anyway – it would damage companies that buy and sell securities to pay pensions and minimise business risk.
Critics predict that because the tax would be so damaging, David Cameron, the prime minister, will continue to block any attempt to impose it in the UK – using the power that every individual member state possesses under European Union (EU) rules to veto any EU-wide tax measures. Needless to say, most supporters of the tax are equally confident that it will see the light of day.
So what, precisely, is this tax that has provoked such vehement praise and censure in equal measure? The EU version of the Tobin tax – presented by the Commission in September – would levy a charge on all financial market transactions made by people or organisations resident in the EU. Several combinations have been suggested, but opinion is coalescing around a tariff of 0.1% on the buying and selling of equities and bonds, and 0.01% on all derivatives transactions. The Commission ventures that this would reduce ‘undesirable market behaviour’, including excessive ‘speculation’.
The Commission’s own impact assessment suggests that a Tobin tax could raise as much as €400bn a year, reduce GDP by up to 1.76% by increasing the cost of capital for corporates, and lead to the disappearance of several hundred thousand jobs. Many of them would be in the UK – the City of London Corporation and other opponents of the levy cite figures indicating the UK would shoulder more than half of the EU’s Tobin tax burden.
But the Commission’s estimate of the levy’s effect looks only at the costs to the economy, without estimating its benefits.
Although the Commission has proposed that the Tobin tax take should be used to shore up the centralised EU budget, member states are eager to see the money raised in each country siphoned to the relevant national government.
Working on the assumption that the money raised in the UK stays in the UK, Owen Tudor, head of EU and international relations at the Trades Union Congress and one of the intellectual leaders of the Tobin tax campaign in Britain, says: ‘Our view is that it would probably have a net overall positive effect.’ He views a Tobin tax as mainly discouraging speculative trading, which he sees as providing no useful purpose to the economy beyond the tax revenue raised from it.
A tax on speculators
Much speculative activity requires frequent buying and selling to exploit market movements – particularly given the increasing popularity of automated, high-frequency trading systems. Since this would incur a tariff every time a transaction was made, the overall Tobin tax bill would be high.
Moreover, the levy would divert money currently invested in speculation into channels that could generate further economic growth, says Tudor. One would be extra public spending using the tax revenue raised. Another might be extra investment in industry by financial services companies that needed to find a new use for funds.
‘The money that would be taxed under this alternative measure is not currently being used in a particularly helpful way’, says Tudor. ‘Instead of the finance sector being designed to serve the real economy, it works the other way round.’
But Sarah Wulff-Cochrane, head of tax policy at the British Bankers’ Association, disputes the notion that some sectors likely to be hit hard by the Commission’s proposal serve no broader purpose.
At the heart of her argument is a view that the activities which the Tobin tax would discourage boost GDP by allowing companies to operate more efficiently. She cites the example of exporters using derivatives to hedge currency risk and quotes the Commission’s impact assessment, suggesting that the volume in derivatives trades, which are often bought and sold rapidly, will fall by between 70% and 90%.
She adds that the damage to employment will stretch far beyond the thousands of people who trade in derivatives and other directly affected markets: ‘In the City of London a large infrastructure supports the complex transactions undertaken by the financial services sector. Jobs in auxiliary services, such as the law and accountancy, will also be affected.’ Critics say that some of this business will be relocated outside the EU, but some will disappear altogether. Either outcome would hit UK GDP. Wulff-Cochrane thinks that by reducing output, the tax may in fact lead to a decline in overall tax revenues.
Hitting the real economy
Matthew Fell, director of competitive markets at employers’ organisation the CBI, agrees that the Tobin tax would damage the UK’s derivatives business, resulting in ‘significant job losses’. However, he adds that the tax ‘would mainly hit the real economy, including pension funds, asset managers, insurance companies and corporates, as both direct and indirect costs will largely be passed on to the end users’.
Fell attacks the assumption of Tobin tax supporters that the levy would primarily hit short-term trading, saying: ‘In reality it does not discriminate, so all transactions would be hit, from risk management products to-long term pension investments.’
Critics also cite research from asset manager BlackRock, which suggests its low-risk Euro Government Liquidity money market fund would incur extra annual costs equivalent to almost 8% of the fund’s value. This would make the fund unviable. Money market funds – low-risk vehicles investing in short-dated bonds since they carry a lower risk of default – are almost the opposite of speculative, high-risk funds.
To UK critics, the damage to money market funds perfectly illustrates the argument that, instead of a scalpel that removes highly specific business lines with surgical precision, the Tobin tax is a sledgehammer that will indiscriminately damage the entire financial sector.
Opponents fear that even financial services businesses not sensitive to the Tobin tax could exit the UK if the tax were imposed in the EU but not in other parts of the world. Efforts by France and Germany to win agreement for it by the G20 group of leading economies have come to naught.
One senior banking figure suggests: ‘If a great part of what you do is going to be taxed more heavily, you might move the whole lot elsewhere.’
He is also fearful that even if the Tobin tax is not agreed, the backlash against financial markets among many EU member states could in future threaten the UK with other damaging taxes on financial services. Asked whether London will still be one of the world’s biggest financial centres in 10 years’ time, he concludes: ‘One hopes that it will remain so, but it’s under exceeding pressure at the moment.’
David Turner, journalist